Hungary is the latest troubled economy that has sought and received an International Monetary Fund (IMF) rescue package. Actually, Hungary’s bailout wasn’t limited to just the IMF’s $15.7 billion. When you add in the $8.1 received from European Union and another $1.3 thrown in by the World Bank, the total package is a whopping $25.1 billion.
Clearly, Hungary was thought to be a crisis case. But financial crisis is nothing new for Hungary—the country has been experiencing economic problems since the early ‘80s. When it entered the post-communist “new era” and joined the IMF and the World Bank, it had the highest per capita foreign debt of any of the former Eastern Bloc countries.
By 2004, when Hungary joined the EU, it was the most economically advanced of the countries to join. But their economy turned into one of the most fundamentally weak, partially due to a dysfunctional multi-party political system—currently consisting of no less than five separate parties.
In September 2006, the state radio broadcast an excerpt from a secret speech by Prime Minister Ferenc Gyurcsany in which he admitted lying about the state of the economy in order to win the election that year. Since then, Gyurcsany's Socialists have introduced unpopular measures that have greatly cut the state budget deficit, a deficit which topped out above 10 percent of GDP during 2006, by far the largest in the European Union. But continual party infighting has made it impossible to completely eliminate the deficit problems that have persisted since the Soviet era.
The government budget deficit stands at 5.5 percent of GDP, the trade deficit is at 5 percent of GDP and the total external national debt is at 122 percent of GDP. Even with all that bad news, the country is still not facing anything approaching the scale of the Icelandic collapse.
Iceland’s banks grew too large and were so over leveraged, their liabilities were equivalent to many times Iceland’s GNP. It was the sheer size of Iceland’s banks, compared to the rest of their economy, that became their main weakness. But Hungarian banks have not played such a major role in their economy, and while the local currency, the forint, has been on a downward slide, foreign currency has been flowing into the country.
Hungarian real estate has seen a huge influx of Swiss franc-denominated mortgages, usually by way of Austrian banks. In fact, since 2006, nearly 80 percent of all mortgages in Hungary have been negotiated in Swiss francs. By the end of 2007, around 40 percent of all mortgages and personal loans in Hungary were in non-euro and non-forint denominated currency.
But in early October, Hungary’s overall economy was so weak and the market for government bonds so frozen, their Finance Ministry contacted the International Monetary Fund (IMF) about a possible support package. Shortly thereafter, the European Central Bank (ECB) announced it was offering a 5 billion euro (US $6.7 billion) loan facility.
The fact that the ECB wants to bail out a non-euro state is an indication that if Hungary’s economy were allowed to unravel, it could have a negative impact on the rest of Central Europe. For example, Austrian banks are heavily invested in the region and any major disruption could have serious implications for Europe’s already troubled banking system.
By mid-October Hungary's stocks, bonds and currency had plunged and Fitch Ratings and Standard & Poor's cut the outlook on the country's debt, forcing the government to lower its economic growth forecast for next year. The forint lost 25 to 40 percent of its value against the euro and the U.S. dollar, and the Budapest Stock Exchange's benchmark BUX reached its lowest point in four years. But with the recent promises of financial support, things are beginning to look up for Hungary.
Below are some highlights of news stories for the month of October as they were announced.
October 18
Prime Minister Ferenc Gyurcsany called a national summit between the government and the central bank but failed to reach an agreement to stem a crisis that battered local markets. Gyurcsany and the central banks pushed for cutting the budget deficit faster than previously planned, while the opposition, which is more popular than the ruling Socialist Party, called for reducing taxes to accelerate growth. It was another political stalemate.
October 22
Hungary’s central bank was forced to raise the benchmark interest rate to 11.5 percent from 8.5 percent, the biggest increase in five years, after the forint plunged more than 20 percent against the euro within three months. But economist Nouriel Roubini said the move would be "risky" if the bank’s actions failed to stem speculation and failed to reverse the fall in the currency value.
In the past couple of years, Hungarians increasingly have chosen to sign up for mortgages and other loans primarily in Swiss francs and euros as a way to take advantage of lower interest rates. But that also meant higher currency exchange risks. For example, with the forint sinking, the monthly installment in October for a loan in Swiss francs could be 15 percent higher than in September.
Meanwhile Hungarian politicians and analysts insisted that the country was nowhere near a bankruptcy crisis like the one that hit Iceland. They pointed out that Hungary’s banking sector is stable because 90 percent of the banks are subsidiaries of foreign institutions, and added that an interest rate hike could help unlock their frozen government bonds market.
October 29
International money lenders agreed on a $25.1 billion rescue package for Hungary. The IMF led the way with a $15.7 billion loan, expressing its confidence that the Hungarian economy will be able to regain stability and improve its long-term growth potential. The European Union (EU) is adding $8.1 billion and the World Bank will supply $1.3 billion on top of the loan to be made available by the IMF.
The IMF’s $15.7 billion was an unusually large loan for an economy the size of Hungary's. Under IMF rules, Hungary should have only qualified for about a quarter of that amount. Even the EU's help is beyond the norm. The last country to be given assistance on such a grand scale was Italy, in the early 1990s. France, the current EU chair, explained that the measure would "reinforce Hungary's balance of payments".
The World Bank normally ranks Hungary among the best performing countries in the middle-income range. So why was the rescue package double the expected size? In a press conference organized by Hungary's Finance Ministry, officials of the IMF and the European Commission explained that the IMF, the World Bank and the EU felt they needed to send a signal strong enough to calm plummeting markets.
October 30
Hungary’s $25.1 billion bailout did settled nerves in the bloc's ex-communist countries, even though the regional fallout from the financial crisis is still unknown.
The larger-than-expected rescue, the biggest for an emerging market economy since the global crisis began, dwarfed the $2 billion and $16.5 billion sums offered earlier to Iceland and Ukraine. But the IMF funding comes with a 17-month Stand by Agreement, which means that Hungary will be forced to make painful budget cuts after two years of austerity, which could make the outlook even worse for an economy heading for recession.
October 31
Analysts agree that the IMF help might actually push the country closer to membership in the euro zone.
Credit Suisse (CS), the Swiss-based international banking and investment advisory service now believes that Hungary is less risky than it was three weeks ago. Using a country economy risk scorecard with five rating factors, they now rank Hungary 12th—ahead of Iceland, Bulgaria, three Baltic states, Ukraine, Romania, Spain, Greece and even the United Kingdom.
The five CS rating factors are:
1. Current Account Balance (C/A) - CS preferred the countries with C/A surpluses. This is the critical factor because a current account deficit cannot be financed. It means that either the currency has to weaken or there has to be domestic deflation.
2. Loan-to-Deposit Ratio - the lower, the better.
3. Level of External Debt - CS was mainly interested in short-term debt relative to foreign exchange reserves.
4. Level of Leverage
5. Net Commodity Exports - CS focused on importers not exporters.
Hungary's lower risk rating is partially due to the fact that the country has shown the greatest signs of improvement in Eastern Europe.
The rest of the world will be looking on to see if Hungary can adhere to the IMF Stand By Agreement and can take the steps necessary to stabilize their economy.
